The creditworthiness of the Indian corporate sector is set to get ample boost with the reduction in corporate tax announced by finance minister Nirmala Sitharaman. Companies, especially those facing tight liquidity conditions, may get more legroom to service debt, which is likely to reflect in lower borrowing costs, as well as higher free cash flows to service existing debt and invest in capex.
The Friday announcement, the latest in a series of fiscal measures announced by the FM to fuel economic growth, will see a reduction of corporate tax rate for companies, which do not avail of any tax incentive, to 22%, satisfying a long-standing plea for lower taxes from India Inc.
The effective corporate tax rate, including surcharge, will now be 25.17%, while new manufacturing companies will have to pay an even lower tax of 15%, or 17.01% inclusive of surcharge and cess. The government has also cut the minimum alternate tax (MAT) rate from 18.5% to 15% for companies that continue to avail exemptions and incentives.
A Mint analysis has shown that over the last 30 months, Indian Inc.’s ability to pay interest on loans had worsened. Now, industry experts say this trend in interest coverage ratios—a key metric to show creditworthiness—will, in all likelihood, begin to reverse. “The industry has been looking for taxes to be lowered so that they can be competitive internationally," said M.V.S. Seshagiri Rao, joint managing director and group chief financial officer, JSW Steel. “Manufacturing companies will start investing more now with the effective tax rates coming down and the extra amounts saved will be used for reinvestment in the business."
“The choice of whether an individual company chooses to forego incentives and pay higher tax rate will depend on their tax liabilities for each year, the net present value of long-term tax savings and their future investment plans," Rao added. “But in either case, we will definitely see cash savings from this move and the interest coverage ratios improving. This will particularly help medium and small companies in our value chain, which are struggling with debt repayments and poor access to bank lending. A tax benefit of ₹1.45 trillion for the economy is a great stimulus."
The interest coverage ratio measures the ability of businesses to pay interest on their loans. Mint’s analysis of the top 500 companies listed on the BSE, excluding financial services firms and oil and gas companies, fell to a 13-quarter low in the three months ended June 2019, amid slowing sales and profit growth. A lower cash outgo because of lower tax rate frees up cash and improves companies’ credit-worthiness.
Vikas Halan, senior vice-president, corporate finance group, Moody’s Investors Service, said: “The government’s decision to reduce base corporate tax from 30% to 22% will boost net income of Indian corporates and is credit positive. Extent of final impact on credit profiles of corporates will depend on whether they utilize the surplus earnings for reinvestment in business, debt reduction or high shareholder returns."